Superior Bank failure report blames execs, regulator

The federal treasury department’s Office of Investigations has been tasked with taking a closer look at the April failure of Superior Bank, specifically its financial reporting of bad loans in 2010.

In a 20-page audit report from the treasury’s Office of Inspector General, the office said it wants investigators to look deeper into Superior management’s questionable timing of reclassifying deteriorating loans, and its failure to use a third party loan review finding in preparing thrift financial reports for the first and second quarters of 2010.

When it failed, Superior was the second-largest financial institution based in the Magic City area with $3 billion in assets.

Its failure – the largest in the nation this year – cost the Federal Deposit Insurance Corp. an estimated loss of $290 million to the Deposit Insurance Fund and a loss of $40 million to the Debt Guarantee Program.

The magnitude of Superior’s hit to the Deposit Insurance Fund required a material loss review under the Federal Deposit Insurance Act.

If the Office of Investigations finds wrongdoing, it could lead to lawsuits by the FDIC against executives and directors to recover damages.

“I’m sure the FDIC will investigate the causes for such a large loss and pursue civil remedies and criminal charges where liability can be established, especially for senior executives and board members,” said Jonathan Hullick, president of Miami-based Bank Performance Solutions and a former senior FDIC regulator and bank executive. “These investigations take time, but those responsible are usually held accountable in the end.”

Efforts to reach former Superior executives were unsuccessful.

Report implicates Superior and OTS

The results of the material loss review, which OIG presented in the audit report, said in addition to masking its deteriorating loans, Superior failed because of its high-risk concentration in commercial real estate, construction and land loans, ineffective credit-risk management, inadequate capital levels and decline in its real estate markets.

The report also said Superior’s regulator, the former Office of Thrift Supervision, could have taken more aggressive steps sooner to curtail the risky actions that led to the thrift’s downfall. The OIG concluded that the OTS was not timely in requiring Superior to establish concentration limits and did not require Superior to maintain higher levels of capital.

Experts said it’s not uncommon for these types of audit reports to say regulators didn’t act soon enough, especially when the OTS was supervising.

“The OTS has been cited for lax supervision in other costly thrift failures, and it had a reputation for being less proactive than the other bank regulators,” Hullick said. “Several of the worst failures, such as Washington Mutual, IndyMac and BankUnited, have been at least partially attributed to ineffective OTS oversight.”

The OTS was combined with the Office of the Comptroller of the Currency in July.

Hullick said ultimately the blame can only be placed on the financial institution.

“Regulatory supervision is important, but primary responsibility for Superior Bank’s failure and the resulting losses rest squarely on the bank’s executive management,” he said.

Masking problems

An OTS review of 95 Superior loans in 2009 revealed that 11 loans, totaling $91.1 million, were not adversely classified, the report said.

However, Superior’s management asserted to OTS that the loans in question were not troubled and continued to disagree with its assessment until the latter part of 2010 when, based on an independent loan review required by OTS and outside investor groups, the thrift’s management began taking action to recognize the credit risk in the portfolio.

According to the report, Superior’s management received the results of the third party loan review in March 2010, but waited more than two quarters to report the results on its thrift financial reports and to OTS.

“The big question for the management will be why they waited to report it,” said Walt Moeling, partner at Atlanta-based Bryan Cave LLC. “If they just didn’t like the findings, that’s not enough. They have to be able to show that they had a rational basis for believing that the loan review and the bank’s examination were both inaccurate.”

In response to the loan review, the thrift’s report of adversely classified loans increased almost 74 percent from $362 million as of Dec. 31, 2009, to $629 million as of Sept. 30, 2010.

Rocky road to the end

Troubles for Superior, which was founded in 1957 as Warrior Savings Bank before changing its name to The Bank in 1998, started during the real estate boom, when – like many banks – it packed its loan portfolio with a high concentration of commercial real estate, construction and land purchases that later failed to materialize. Superior concentrated its lending activities in Birmingham and Huntsville markets and the areas of Tampa, Sarasota and the Gulf Coast of Florida.

Superior received guidance from its regulator in 2006 on concentrations in commercial real estate lending and sound risk management practices, but the regulator noted in 2009 that Superior had not established the concentration limits as required. That failure to establish prudent risk limits was viewed by OTS as “an unsafe and unsound condition” and prompted the regulator to require the thrift to establish concentration limits.

While OTS asked Superior for corrective action, the inspector general office’s audit concluded that the regulator was not timely in requiring Superior to establish concentration limits considering that the thrift had high-risk concentrations four years earlier in 2005.

Superior’s capital levels were just above well-capitalized from 2006 to the fourth quarter of 2008, but the OTS noted in its 2008 report of examination that Superior’s capital margins were thin because of the thrift’s higher-risk concentrations. Yet, OTS did not require Superior to hold additional capital, OIG said.

Superior’s capital level began to rapidly decrease in 2010, falling to 8.85 percent in the second quarter; to 5.04 percent in the third quarter; and to 1.03 percent in the fourth quarter.

Superior failed on April 15 and its assets were purchased by Community Bancorp, which changed its name to Cadence last month.

According to the report, OTS examiners told OIG auditors that higher levels of capital may have minimized the loss to the Deposit Insurance Fund and may also have restrained Superior’s higher-risk lending as it grew in its loan portfolio.

The OIG did not make any recommendations for preventing such a loss in the future because OTS’s functions were moved to OCC.